Commissioner wins tax avoidance case against Cullen Group Limited in the amount of $51.5m plus interest and penalties

Summary

This matter concerned Cullen Group Limited's ("CGL") challenge to the Commissioner of Inland Revenue's ("the Commissioner") assessment that CGL avoided $59.5 million of non-resident withholding tax ("NRWT"). CGL had paid $8 million in approved issuer levy ("AIL"), leaving a shortfall of $51.5 million. CGL argued that the arrangement involved the restructuring of Mr Eric Watson's affairs in order to achieve certainty about his change of tax residency from New Zealand to the United Kingdom and to plan for application of the United Kingdom's laws governing remittance of foreign-sourced income. In finding for the Commissioner, the Court did not consider the arrangement was within the contemplation and purpose of Parliament in enacting the AIL regime. It had a more than merely incidental purpose or effect of altering the incidence of tax and was a tax avoidance arrangement which was void against the Commissioner.

Impact

This decision reaffirms the law on tax avoidance as set out in the Supreme Court's decision in Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 289("Ben Nevis").It further reconciles the minority and majority decisions in Ben Nevis regarding the interplay between the use of specific tax provisions and, for the general anti-avoidance rule in s BG 1 of the Income Tax Act 2007 ("the ITA"), Parliament's contemplation of how those provisions should be used.

Facts

Mr Watson moved from New Zealand to the United Kingdom in 2002.  He was concerned to ensure his "permanent place of abode" for tax purposes changed from New Zealand to the United Kingdom.   

On 13 November 2002, Mr Watson restructured his ownership of Cullen Investments Ltd ("CIL"). The key steps were:

• Mr Watson sold his shares in CIL to CGL, at a rounded value of $193m, being $291m less his previous shareholder advances of $98m.  The purchase price of $291m was accepted as at market value.

• CGL's purchase of the shares was funded by a vendor loan from Mr Watson of $193m (Loan A).  Mr Watson also lent CGL $98m (Loan B) which CGL on-lent to CIL so that CIL could repay Mr Watson's shareholder advances.

• Mr Watson assigned Loans A and B to two conduit companies in the Cayman Islands, Modena Holdings Ltd (Modena) and Mayfair Equity Ltd (Mayfair) with back to back loans of $193m (Modena Loan) and $98m (Mayfair Loan) to Modena and Mayfair.

The effect of all of this was that CGL owned CIL, CGL owed $193m to Modena and $98m to Mayfair, Modena owed $193m to Mr Watson and Mayfair owed $98m to Mr Watson.  Effectively, instead of owning shares in CIL, Mr Watson held loans for the same value to CGL through Modena and Mayfair; he had exchanged equity for debt.

The terms of Loans A and B from Mr Watson to the CGL (which he assigned to Modena and Mayfair) included:

• Modena and Mayfair could only request repayment a loan, or part thereof, from CGL if Mr Watson had demanded repayment of the corresponding Modena or Mayfair loan. Modena or Mayfair's demand to CGL was to be contemporaneous with, and not exceed the amount specified, in Mr Watson's demand to Modena or Mayfair.
• Interest was payable at 16% per annum. The Court accepted this reflected an arms' length arrangement.
• CGL could not assign or transfer its rights or obligations under the loans.  Mr Watson, as lender could assign his rights but any other lender, including Modena and Mayfair, could only assign them back to Mr Watson or with his agreement.
• CGL was to register each loan with the Commissioner as a registered security for AIL purposes and make payment of AIL to the Commissioner.

Modena and Mayfair entered into a memorandum of understanding with CIL in December 2002 under which their directors delegated to CIL employees the power to effect transfers of funds from Modena's and Mayfair's BNZ accounts to Mr Watson's BNZ accounts.  Further, when CIL sought the consent of third party financiers, CIL stated "[t]he change is an internal reorganisation and has no practical effect on the control of Cullen and its group companies".

When the arrangement was unwound, Mr Watson demanded repayment from Modena (then owing $587.5m) and Mayfair (then owning $140.9m) and Modena and Mayfair assigned Loans A ($587.5m) and Loan B ($140.9m) to Mr Watson. Mr Watson made demand on CGL for repayment of Loans A and B. CGL entered a deed setting off the loans in return for issuing non-voting redeemable preference shares, redeemable at the holder's option and with no dividend payable.  Mr Watson transferred the preference shares to Novatrust Ltd, a professional trustee company in Jersey, as trustee for the Summit Trust, funded by loan agreements with Mr Watson for $728.4m ($587.5m + $140.9m) with the shares in CGL used as security. 

CGL applied for approved issuer status and registered Loans A and B as registered securities.   From March 2003 to November 2008, CGL paid AIL of 2% on the $397m interest it paid, or credited in account, to Modena and Mayfair, amounting to just over $8m.
In 2010, the Commissioner assessed CGL for NRWT at 15% on the $397m interest, amounting to around $59.5m. Offsetting the $8m of AIL already paid, the resulting tax liability was around $51.5m and CGL challenged the NRWT assessments in the High Court. 

Decision

As a preliminary point, the High Court ruled that evidence from CGL's experts responding to positions of the Commissioner earlier in the dispute process (rather than the Commissioner's expert briefs exchanged in the challenge) and proposed evidence about the legal effect of a Double Tax Agreement (DTA) on the New Zealand withholding tax rate, being legal submissions, were inadmissible.

The Court noted that the general approach to construing specific tax provisions and the general anti-avoidance provision in New Zealand tax law is now well-settled.  The leading authority is Ben Nevis Forestry Ventures Ltd v Commissioner of Inland Revenue [2008] NZSC 115, [2009] 2 NZLR 389.  Relevant to this case, and bearing in mind that the burden of proof is on the taxpayer, the three requirements for tax avoidance are:

• The arrangement uses, and falls within, specific tax provisions.
• Viewed in light of the arrangement as a whole, the taxpayer has used the specific provisions in a way which cannot have been within the contemplation and purpose of Parliament when it enacted the provision.
• The arrangement has a purpose or effect, that is more than merely incidental, of altering the incidence of tax. 

The Court set out the arrangement at paragraph [39] and the parties agreed that the arrangement fell within the specific provisions of the ITA and the Stamp and Cheque Duties Act 1971 ("SCD") in relation to NRWT and AIL. The Court set out the law on NRWT, AIL and s OD 7 of the ITA 1994 (the relevant associated person section at the time of the arrangement).  The Court queried whether CGL and Modena or Mayfair may be associated under the "control by any other means" subsection, which potentially encompasses control in terms of economic substance, but accepted that the Commissioner was bound by her pleadings that CGL was not, legally, an associated person of Modena or Mayfair.

The Court then considered whether the specific tax provisions were used in a way which cannot have been within Parliament's contemplation.  This case raised directly the question of the difference between a purposive interpretation of specific tax provisions and Parliament's contemplation of how those provisions should be used.  For there to be tax avoidance, the arrangement must fall within the meaning of the provisions, construed in light of their purpose, but outside the way in which Parliament contemplated they be used.  

Judicial understanding of Parliament's purpose in enacting the legislation informs but does not substitute for judicial interpretation of the words Parliament enacted.  The "parliamentary contemplation" stage of the s BG 1 tax avoidance inquiry is wider than simply a purposive interpretation of the text of specific provisions.  It is important that it is the "use" of specific provisions and this is an "intensely factual" exercise, focusing on how the arrangement has used, or deployed, the specific provisions. Viewed objectively, in a commercially and economically realistic way, is that use consistent with Parliament's purpose or contemplation?  Artificial and contrived structuring of an arrangement is a "classic indicator" that the use is not consistent with Parliament's contemplation.

The Court found that there was no doubt the arrangement here involved highly complex and contrived ownership structures that would not be found in arms' length relationships.   Neither the lender nor the borrower was independent here.  Mr Watson exchanged equity in CIL for debt owed by CGL back to him ultimately.  The level of control that Mr Watson had was usually an incident of ownership of equity, not debt.  The ownership and debt relationships were structured in such a way as to allow Mr Watson, through CGL, to pay AIL at 2% rather than NRWT at 15%. 

After traversing the background of the AIL regime, introduced in the 1991 Budget Night amendments, the Court agreed with the Court of Appeal, High Court and TRA in Vinelight Nominees Ltd v Commissioner of Inland Revenue that the objective of the AIL regime is to encourage investment in New Zealand by reducing the cost of New Zealand residents borrowing from non-residents. The Court accepted the expert evidence that no new funds were introduced into New Zealand by the arrangement and, objectively, viewed in light of the arrangement as a whole, CGL used the specific provisions in a way that cannot have been within the contemplation and purpose of Parliament when it enacted the provisions. 

The Court concluded that payment of AIL was a key element of Loans A and B and altering the incidence of $51.5m of tax was not merely incidental. Here, the Commissioner was entitled to make her assessment on the basis that CGL was liable to pay NRWT and did not need to exercise her reconstruction discretion under s GB 1 of the ITA. 

The Court also found that the NRWT rate should not be 10% (the NRWT rate under the New Zealand / UK DTA) nor were the assessments timebarred. 

Accordingly, the Court dismissed CGL's challenge and upheld the NRWT assessments for $51,496,127.38 plus use of money interest and penalties.